More on the possibility of Japan diversifying its foreign reserves

July 14, 2007
By Ken Worsley

Stephen Jen seems to have kicked off a flurry of media activity since suggesting last week in the Morgan Stanley Global Economic Forum that Japan start up a sovereign wealth fund. Whether or not that is the exact path Japan chooses, the idea of diversifying the nation’s foreign reserves has been all over the news this week. With Japan’s foreign reserves rising to $913.57 billion at the end of June from $911.14 billion in May (though still just below April’s record high of $915.62 billion), and with China and Russia both having set up foreign reserve management funds, we are bound to hear more on this issue in the ~~days~~ ~~weeks~~ months to come.

We know that Chief Cabinet Minister Yasuhisa Shiozaki supports diversification of the funds, and that Finance Minister Koji Omi prefers to err on the side of caution. We also know that Shiozaki (and his boss, Shinzo Abe) is the much younger man. Omi may have seniority, but how much longer will he be around? One thing is for sure: if Abe keeps the top job after this month’s Upper House election (good chance), there is the possibility of a Cabinet shakeup (not as good a chance, but possible). With Abe in charge, Shiozaki is going nowhere; despite some problems managing the Cabinet, it seems certain that he will be in there to stay. Omi, on the other hand, may move on (though, with Omi being scandal-free, this may not be totally possible).

</Near wild speculation>

Nonetheless, should diversification of the funds (which are about 90% in US dollars) be determined to be desirable, Omi’s Ministry of Finance will become an obstacle. Now, with both Financial Services Minister Yuji Yamamoto and Takatoshi Ito, a close adviser to the Prime Minister, both urging diversification of foreign reserves, we have to wonder if pressure is intentionally being placed on the Ministry of Finance from the flanks.

As Forbes put it, such comments in support of diversifying foreign reserve funds:

…come within a widening trend among reserve-rich Asian countries to diversify out of dollar assets in the search of better returns by means of more proactive investment methods. Singapore, South Korea, and most recently China, have all set up sovereign wealth funds, but Japan — the largest holder of currency reserves — has so far resisted doing so.

(As far as I’m aware, the value of China’s foreign currency reserves is greater than Japan’s, at $1.333 trillion for China versus $913.6 billion for Japan)

At any rate, the Wall Street Journal is now discussing the possibility of Japan shaking up the way it manages its foreign reserves, and its writer mentions Jen’s piece without any counterpunch quotes (though I’m not finding many, and I agree with the thrust of Jen’s argument, but was just trying to see if anyone’s been writing from the other side, or playing devil’s advocate on purpose).

What would happen if it starts to seem as though Japan will diversify the management of its foreign reserves? According to a Barclays Capital strategist quoted in the WSJ piece:

If the market starts to speculate that the Japanese government will establish a public investment corporation and convert the U.S. dollar assets in its foreign-currency reserves into euro, this could lead to speculative purchases.

And if the market speculates that it won’t?

Filed Under Foreign reserves, Japan